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U.S. E&P Cash Flow, Spend Trending Much Higher in 2017, Says Raymond James

U.S. exploration and production (E&P) cash flow generation and oilfield spending on drilling and completions have bottomed, no matter what direction oil and natural gas pricing goes in 2017, Raymond James & Associates said Monday.

At West Texas Intermediate (WTI) oil futures prices currently around $50/bbl, domestic E&P cash flow should improve by about 15% in 2017, said analysts J. Marshall Adkins and Praveen Narra. Raymond James bullish 2017 price deck calls for a huge $30-plus oil price increase next year -- 65% higher than current futures prices -- and at that rate, 2017 cash flow could explode, rising 170% over 2016 levels.

Next year's output also could surprise to the upside, the duo said.

"On the back of what we anticipate to be higher-than-expected spending from the publicly traded U.S. E&P sector, production levels from the group should surprise meaningfully to the upside," Adkins and Narra noted. E&P cash flows "should increase 170% in the next 12 months. Further...we expect our E&P coverage group to see production growth of 8% in 2017 versus consensus estimates for 3%."

The exploration sector is not as levered as Wall Street often claims, analysts argued. The sector is capital-intensive and carries lots of debt, but in aggregate the levels have been about the same in the past five years.

And E&P cash flows also are "highly sensitive" to even moderate commodity price changes. A $10/bbl increase could result in a 60% jump in E&P cash flows, according to Raymond James. The bullish Raymond James energy team is "highly confident" that WTI will be higher in 2017 than this year.

While E&P capital expenditures (capex) initially are going to follow rising cash flow, an expected industry bottleneck in pressure pumping by the oilfield services (OFS) sector could limit industry's ability to ramp up too fast.

"This inability of the OFS industry to respond to rising demand for services on a timely basis is a big part of our logic for 2017/2018 oil prices overshooting a more sustainable long-term oil price in the $60-70 range," analysts said. "Put another way, we see oil futures understating where oil prices need to be in 2017 and 2018 to repair the seriously injured U.S. OFS industry and eventually remove the cap on U.S. supply growth constraints" (see Shale DailySept. 19).

Because U.S. producers were quicker to react in the downturn, they should be more responsive in the upturn.

There are, of course, caveats. Publicly traded U.S. independents traditionally have been the "most innovative, best capitalized and most aggressive spenders," but they don't represent the "real" industry, Adkins and Narra noted. Publicly traded U.S. independents represent about one-third of domestic oil production, with privates and majors responsible for the other 67%. However, the public E&Ps offered cost and hedging "guideposts" for the analysts' top-down U.S. cash flow and spending model.

"Since the shale boom began in 2010, U.S. publicly traded E&P operators have typically outspent cash flows on a year-to-year basis even more than the industry in general," analysts said. The big public E&P mantra during the downturn has been to spend within cash flow and pare debt. The reality -- or at least expectations moving into 4Q2016 -- is seemingly a much different story. It is naive to think that the 'outspend or die' philosophy would not continue even as the industry begins to haggardly limp away from 13-year low oil prices."

Public E&Ps should continue to spend more than the cash flow they generate, the analysts argue.

Of the 27 U.S. pure-play E&P companies under Raymond James coverage, consensus estimates put the cash flow outspend at 17% this year. The Raymond James team is estimating it a bit lower, forecasting the group may outspend by 13%. That compares with a 40% outspend in 2015. The continued outspend comes from a "heavy dose of external financing," analysts said.

"In total, publicly traded U.S. E&Ps have sold 1.2 billion shares of common stock for proceeds of nearly $23 billion so far this year. That already tops the $16 billion issued in all of 2015."

Equity sales, netted against those used only for acquisitions and coupled with asset divestitures, dwarf the cash deficit that is expected to occur. However, while still leveraged, the U.S. E&P sector has cleaned up the balance sheets and are finding access to capital markets.

"With cash flows bottoming in 2016, it would appear that the worst is now behind the E&P industry," Adkins and Narra said. The "wounded" E&P balance sheets largely have been neutered by close to $23 billion in equity raises from the sector.

"With cash flows increasing and balance sheets in better shape, we expect to see the U.S. E&P industry grow oil production by 2% in 2017," they said. "More importantly, the cycle is turning and in that scenario, everyone wins."

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